572 F.

2d 155

FIRST NATIONAL BANK OF MINNEAPOLIS, a National

Banking
Association, Appellant,
v.
FIDELITY NATIONAL TITLE INSURANCE COMPANY, a
Nebraska
Corporation, Appellee.
No. 77-1119.

United States Court of Appeals,

Eighth Circuit.
Submitted Oct. 14, 1977.
Decided March 1, 1978.

Frank F. Pospishil, Abrahams, Kaslow & Cassman, Omaha, Neb., for

appellant.
Robert J. Becker, Swarr, May, Smith & Andersen, Omaha, Neb., for
appellee.
Before BRIGHT, WEBSTER, * and HENLEY, Circuit Judges.
BRIGHT, Circuit Judge.

This litigation commenced after the collapse of a complicated scheme to

develop a parcel of real estate. Defendant-appellee Fidelity National Title
Insurance Company was the title insurer of the development land, and plaintiffappellant First National Bank of Minneapolis was the short-term development
lender. Their dispute is over who shall bear the monetary losses caused by
encumbrances of record that are prior in right to First National's mortgage. First
National contends that Fidelity Title insured it as a first lienholder of the land
and therefore seeks a declaratory judgment that Fidelity Title is liable under its
policy to protect the Bank against the superior liens. After holding a hearing on
the parties' cross-motions for summary judgment, the district court entered
judgment for defendant Fidelity Title on January 10, 1977. Because it appears

to us that disputed issues of fact exist that bear on liability, we reverse and
remand the case for trial on the merits.
I.
2

Winchester Heights is a 348-lot subdivision located in the northwest part of

Omaha, Nebraska. In 1973, Dial Investment, Inc. possessed purchase options
for the property, which the Klinker family then owned. The parties had agreed
upon a purchase price of $226,000.

On September 5, 1973, after several months of negotiations, Jack Karnes,

president of Dial Realty, Inc. (a sister company of Dial Investment, Inc.),
obtained a commitment for permanent financing of the Winchester Heights
development from the Ford Motor Credit Company. Karnes was assisted in the
negotiations by the Heitman Mortgage Company, a mortgage brokerage firm.

The commitment for permanent financing was contingent upon the completion
of certain improvements at Winchester Heights, consisting primarily of site
grading, installation of sewer and water lines, and construction of streets. To
finance the improvements an interim loan was necessary, and Heitman
contacted First National. In a letter dated September 27, 1973, First National
agreed to make the necessary interim loan, contingent on agreement between
the parties on the form and substance of necessary loan documents.

In October 1973, representatives of First National, Heitman, Dial Realty, and

Dial Investment met to discuss the details of the interim construction loan. At
this meeting, Jack Karnes, representing both Dial Investment and Dial Realty,
proposed that the interim construction loan "wrap-around"1 a purchase money
mortgage on real estate. Apparently the Klinkers, owners of Winchester
Heights, had consented to finance Dial Investment's purchase of the property by
accepting three purchase money mortgages for the full sale price of the real
estate ($226,000). These purchase money mortgages had an interest rate of 7%,
considerably lower than the rate demanded by First National (31/2% Over
prime, or about 15%). Accordingly, Karnes hoped to save money for his two
companies, Dial Investment and Dial Realty, by persuading First National to
"wrap" its loan "around" the first and superior mortgages to be held by the
Klinkers rather than proceeding in the "normal" fashion of using interim loan
proceeds to pay off immediately the superior obligations. With this goal in
mind, Karnes proposed that First National secure its loan by a second mortgage
on the property and development (in a "wrap-around" position) but
retain.$390,000 of the $1,300,000 interim loan to pay off the prior mortgages
and accumulated interest in the event of default. Thus, while the proposed

scheme would save Dial Investment interest costs, it would also put First
National in the position of an inferior lienholder.
6

From this point the evidence is contradictory. After concluding that the wraparound arrangement was legally feasible, First National agreed to study the
proposal further. The parties also discussed obtaining title insurance for the
proposed transaction. First National suggested obtaining a clean title insurance
policy that excluded references to the Klinker mortgages and gave it a first lien
on the Winchester Development. The purpose of this clean title insurance
policy is disputed by the parties, however. First National contends that it was
purely for its own benefit and protection. The proposed wrap-around scheme
left First National in a position of a second lienholder, and it viewed its
prerogative to withhold.$390,000 of the loan proceeds to pay off the prior liens
as inadequate protection. Other evidence supports a contrary purpose. In
particular, some testimony indicates that both First National and the long-term
lender, Ford Motor Credit Company, required a clean title in order to comply
with internal policies designed to avoid auditing difficulties. This testimony
suggests that the clean title was intended to be a subterfuge, disguising the true
agreement and economic posture of the parties. It is clear that First National
was willing to become the interim lender and that it was relying to a great
extent on the financial integrity of Karnes and Donald Day, owners of Dial
Investment and both wealthy men, to protect its interest.2 Neither Karnes nor
Day ultimately executed the loan documents as individuals, however.3

The confusion continued after the meeting. Some testimony indicated that both
First National and Dial Investment agreed to abandon the wrap-around scheme.
Karnes, however, testified that Richard Peterson of First National consented to
the wrap-around proposal and that its implementation continued.

Sometime after the meeting, Karnes contacted Kathryn Plourde, vice-president

and counsel for Fidelity Title, to determine whether Fidelity Title would issue
First National a clean title insurance policy in spite of the prior encumbrances,
the Klinker mortgages. Fidelity Title agreed to issue the policy but made its
acceptance contingent on First National's acceptance of the wrap-around
scheme. When Karnes later called and stated that First National had accepted
the deal, Fidelity took his word for it, even though Karnes was not an agent of
First National.

Fidelity Title also requested a copy of the building loan agreement from Karnes
to verify that sufficient funds would be reserved in order to discharge the
encumbrances (the three Klinker mortgages) omitted from the policy. For
unknown reasons, Fidelity Title was never furnished with a copy of the

building loan agreement and did not follow through on its request to examine it.
10

On April 4, 1974, First National and Dial Investment signed the building loan
agreement. The agreement provided, in part:

11is hereby understood and agreed that BORROWER has incurred an indebtedness
It
in the sum of $226,000.00 to Anna C. Klinker and John Klinker ("Klinker"), said
indebtedness being secured by a Real Estate Mortgage by and between Dial
Construction Company, Inc. and Klinker covering that certain property described in
Exhibit "C" attached hereto and made a part hereof. BORROWER hereby represents
that it has caused the Title Insurance Company to delete reference to the said Real
Estate Mortgage from its Policy of Title Insurance in favor of LENDER, and has
caused the Title Insurance Company to guarantee to LENDER that LENDER's lien
is a first mortgage against said property. BORROWER hereby authorizes LENDER
to reserve the sum of THREE HUNDRED NINETY THOUSAND AND NO/100
($390,000.00) DOLLARS to enable LENDER, at any time hereafter, to pay off the
said Klinker Mortgage; and BORROWER hereby appoints LENDER its attorney-infact for the purposes of paying off such indebtedness to Klinker. Nothing herein
contained shall impose upon LENDER any such obligation to pay off the said
Klinker Mortgage. BORROWER hereby agrees that any default under the terms of
the said Klinker Mortgage which would enable the Klinkers to foreclose said
Mortgage, shall also constitute a default hereunder. (Emphasis added)4
12

Significantly, the agreement authorizes the lender to reserve.$390,000 to

discharge the Klinker mortgages, as contemplated by the proposed wrap-around
financing scheme, but does not obligate the lender to use the money for that
purpose. On the same day, Dial Investment executed and delivered to First
National a promissory note and mortgage for the interim loan. These
documents were subsequently recorded by First National.

13

The next day, April 5, 1974, Peter Hess, on behalf of Heitman Mortgage
Company (the mortgage broker), sent the following letter to Kathryn Plourde of
Fidelity Title:

14 connection with that certain Mortgage Loan in the principal amount of

In
$1,300,000.00, being made by First Minneapolis to Dial Investment Company,
please be advised that the undersigned will cause to be deposited with you the sum
of approximately $500,000.00 sometime next week.
15 should have, on this date, recorded the Mortgage from Dial Investment
You
Company to First Minneapolis. On the date that you disburse the funds which I will
cause to be deposited with you as aforesaid, you are to be in a position to issue to

First Minneapolis (but to be sent to the undersigned) your standard ALTA Loan
Policy-1970 with ALTA Endorsement Form 1 coverage (amended 10-17-70) with
Endorsements attached insuring over the questions of Usury and Truth-In-Lending
and insuring First Minneapolis in the amount which you disburse as holder of record
of a first and superior lien upon the mortgaged premises as of the date of your said
disbursement * * *. (Emphasis added)
16

On March 22, 1974, Dial Investment purchased Winchester Heights from the
Klinkers and gave them purchase money mortgages that were recorded on May
13, 1974. Fidelity Title then issued title policy M 14627 on April 29, 1974. The
policy insured First National against loss or damage, not exceeding $1,300,000
(the full amount of the interim loan), sustained by reason of any lien or
encumbrances on the title to Winchester Heights, other than those set forth in
Schedule B of the policy.5

17

The Klinker mortgages were not among the exceptions specifically listed on
Schedule B. Another part of the policy, however, titled Exclusions From
Coverage, "expressly excluded from the coverage of this policy:"

18
Defects,
liens, encumbrances, adverse claims, or other matters (a) created, suffered,
assumed or agreed to by the insured claimant * * *.
19

The interpretation of this clause is fundamental to the outcome of this case.

20

Although Fidelity Title now alleges that the Klinker mortgages constituted
prior encumbrances excluded from coverage under the policy by the express
language of paragraph 3(a) of the Exclusions From Coverage and also by
agreement of the parties, it obtained additional protection in the form of an
indemnity agreement from Dial Investment and the principals of that
corporation, Karnes and Day:

21 consideration of your having agreed to issue a Mortgagee's policy affording

In
extended coverage in the amount of One Million Three Hundred Thousand Dollars
($1,300,000.00) in the name of Dial Investment Company, Inc., insuring the priority
of the lien of a mortgage to First Minneapolis, a national banking association, in said
amount, omitting from the policy a mortgage from Dial Investment Co. to Anna C.
Klinker, a widow, filed in Book 2019 at Page 13 of the Mortgage Records of
Douglas County, Nebraska, and a mortgage from Dial Investment Co. to John
Klinker and Marvely Klinker, husband and wife, filed in Book 2019 at Page 16 of
the Mortgage Records of Douglas County, Nebraska;
We hereby agree to indemnify Fidelity National Title Insurance Company to the full
22

extent of any costs, expenses, or losses of any nature whatsoever which said
company may sustain or incur by reason of the omission of the above described two
mortgages on the Mortgagee's policy. (Emphasis added)
23

The development scheme collapsed on February 28, 1975, when Dial

Investment defaulted on its mortgage obligation to First National. At that time
Dial Investment owed First National $752,690.28, excluding interest. First
National then began mortgage foreclosure proceedings in the District Court of
Douglas County, Nebraska joining all interested parties as defendants, including
the Klinkers. The Klinkers counterclaimed, contending that contrary to the
provision of title policy M 14627, their mortgage liens were prior. First
National notified Fidelity Title of the counterclaim and requested that Fidelity
defend it. Fidelity refused to do so, and First National instituted a third party
action against Fidelity Title as part of the same proceeding.

24

On April 26, 1976, the state court entered a decree in the foreclosure
proceedings finding that the Klinker mortgages were prior to First National's
lien. First National then commenced the present action in federal district court
seeking a declaratory judgment that Fidelity Title was liable as title insurer for
the full amount owed First National.

II.
25

The parties agree on one essential point: Our analysis must begin with the
terms of the title insurance policy. In particular, our task is to determine
whether or not the Klinker mortgages were encumbrances "created, suffered,
assumed or agreed to" by First National under the language of paragraph 3(a) of
the title policy's Exclusions From Coverage.

26

In addition, appellant First National claims that even if it did create, suffer,
assume or agree to the Klinker mortgages, Fidelity Title "waived" the exclusion
and now is "estopped" from asserting it. Appellant's assertion of a second basis
for recovery only serves to obscure the fundamental question in the case,
however. Which party assumed the risk of the developer's failure? In other
words, did First National accept a position as secondary lienholder to the
Klinker mortgages notwithstanding the terms of its insurance coverage?
Alternatively, did Fidelity Title agree to give First National a clean title
insurance policy even though it knew of the existence of the prior
encumbrance? If Fidelity Title assumed the risk, then of course it has "waived"
the paragraph 3(a) exclusion and is "estopped" from asserting it. To use those
terms, however, does not create an additional ground for questioning the district
court's decision.

27

28

Although both parties spend a great deal of time in their briefs debating the
definitions of "created, suffered, assumed or agreed to," we deem that
discussion to be largely irrelevant. As we have already stated, the real question
is who agreed to bear the risk of default and the consequent priority of the
Klinker mortgages.
The terms are useful in one sense, however; they define the perspective that the
court must use in judging the parties' intentions vis-a-vis the title insurance
policy. The paragraph 3(a) exclusion indicates that the insured, First National,
must create, suffer, assume or agree to the encumbrance. Thus, in reviewing the
evidence we must focus on items that bear on the intent of First National.

III.
A.
29

We begin by observing that the body of the title policy insures First National
against "(a)ny defect in or lien or encumbrance on such title" subject to the
exclusions from coverage and exceptions contained in Schedule B. Because the
Klinker mortgages were not expressly excluded from coverage in Schedule B
this language obviously implies that First National is insured as first lienholder,
and the burden falls upon the insurer, Fidelity Title, to prove that First National
agreed to an exclusion from the coverage, i. e., that it "created, suffered or
agreed to" the Klinker mortgages. Familiar construction principles support this
conclusion. As a general rule insurance policies are construed in favor of the
insured and against the insurer. Because the insurer typically drafts the
insurance contract, it is in the best position to protect its interest. Thus, in order
to balance the scales, ambiguities are construed against the insurer. Therefore,
the burden of proof properly falls upon the insurer, Fidelity Title, to establish
the existence of an exclusion from coverage.

30

To assess the intent of First National relative to the insurance policy we must
turn to extrinsic evidence. Nebraska law6 permits the use of parole evidence to
interpret ambiguous contractual terms. See, e. g., Smith v. Cobleigh Elec. Co.,
196 Neb. 711, 246 N.W.2d 55 (1976).

31

In its review of the evidence before it rendered summary judgment in favor of

the defendant, the district court determined that:

32
Despite
(Banker) Peterson's testimony that he would not have disbursed any funds
under the loan agreement in the absence of the title insurance policy insuring the
first mortgage lien on the Bank, this misplaced reliance based upon the conduct of

the parties cannot justify recovery. The very language of the loan agreement states
that Dial "has caused the Title Insurance Company to guarantee to Lender that
Lender's lien is a first mortgage against said property."
The court concluded:
33 "tangled web" weaved by the parties to the loan transactions in October or
The
November, 1973, was an unconscionable scheme for which defendant cannot be
held liable.
34

We review these crucial comments in the memorandum opinion against the

backdrop of Federal Rule of Civil Procedure 56(c), which restricts summary
judgment to cases where the evidence shows "no genuine issue as to any
material fact." We recently commented in reference to Rule 56(c) that

35 is an extreme remedy which is not to be granted unless the movant has

(I)t
established his right to judgment with such clarity as to leave no room for
controversy and that the other party is not entitled to judgment under any
circumstances; the court must view the facts most favorably to the party opposing
the motion and give that party the benefit of any reasonable inferences to be drawn
from the facts. (Unlaub Co. v. Sexton, 568 F.2d 72 at p. 76 (8th Cir. 1977).)B.
36

In the lower court, Fidelity Title sought to prove (and succeeded in convincing
the district court as a matter of law) that the title insurance policy was subject to
a collateral agreement: the building loan agreement. That agreement authorized
First National to retain.$390,000 of the loan proceeds to pay off the Klinker
mortgages. From this Fidelity Title infers that:

37 National * * * permitted and agreed to the Klinker indebtedness on the

First
property and by virtue of the ability to pay them off at anytime, could have
prevented their lien at anytime.
38

In rebuttal, First National points out that: (a) although it was permitted to
retain.$390,000 of the loan proceeds to pay off the Klinker mortgages, it was
not required to do so; (b) the building loan agreement also contained the
following language:

39
BORROWER
hereby represents that it has caused the Title Insurance Company to
delete reference to the said Real Estate Mortgage from its Policy of Title Insurance
in favor of LENDER, and has caused the Title Insurance Company to guarantee to
LENDER that LENDER's lien is a first mortgage against said property.

40

First National also relies on the letter sent by attorney Hess on behalf of
Heitman, the mortgage broker, to Kathryn Plourde of Fidelity Title on April 5,
1974, in which Hess declared:

41 should have, on this date, recorded the Mortgage from Dial Investment
You
Company to First Minneapolis. On the date that you disburse the funds which I will
cause to be deposited with you as aforesaid, you are to be in a position to issue to
First Minneapolis (but to be sent to the undersigned) your standard ALTA Loan
Policy-1970 with ALTA Endorsement Form 1 coverage (amended 10-17-70) with
Endorsements attached insuring over the questions of Usury and Truth-In-Lending
and insuring First Minneapolis in the amount which you disburse as holder of record
of a first and superior lien upon the mortgaged premises as of the date of your said
disbursement * * *. (Emphasis added)
42

This evidence, even without considering the contradictory testimony within the
depositions of the various principals participating in contract negotiations, is
enough to convince us that summary judgment was improvidently granted. This
is not a case in which one party "has established his right to judgment with such
clarity as to leave no room for controversy." Unlaub v. Sexton, supra, at 76.
Indeed, we are hard-pressed to say in which direction the evidence tilts in this
case. On the record before us we certainly cannot conclude that the transaction
constituted an unconscionable scheme on the part of the plaintiff-Bank. The
parties apparently both relied on the financial worth of Karnes and Day. Neither
party expected the development to fail; accordingly, they neglected to allocate
unequivocably the risk to one party or the other.

43

As a final note, we direct the district court's attention to the discussion in parts
II and III A of this opinion. The court must focus on evidence related to the
intent of First National because it is the party that must create, suffer, assume or
agree to the prior encumbrances. For that reason, evidence about Fidelity Title's
intent or purpose is largely irrelevant. The burden also rests upon Fidelity Title
to prove by a preponderance of the evidence that First National assumed,
suffered or agreed to the prior encumbrance.7

44

The resolution of that issue is one of fact, not law. First National's knowledge
that prior encumbrances existed will not absolve the insurer from liability for
them unless the insurer also establishes by a preponderance of the evidence that
the bank agreed that its mortgage would occupy a secondary position to the
purchase money mortgages.

Judge Webster concurred in this opinion prior to leaving this court to become

Judge Webster concurred in this opinion prior to leaving this court to become
Director of the Federal Bureau of Investigation

A "wrap-around" loan, as Karnes understood it, is one in which a lender makes

a loan that is subordinate to another debt with the responsibility and ability to
cure defaults and make payments on the superior debt. The technique is often
used in situations where the superior debt has a lower rate of interest than the
wrap-around financing. The borrower saves interest charges by "wrapping" the
inferior debt "around" the superior debt, rather than using the additional
financing to pay off the first or superior mortgage. Peter Hess, a lawyer
representing Heitman Mortgage Company in the negotiations, testified in his
deposition that Karnes misused the term in applying it to this transaction

Richard Peterson, assistant vice president of First National and First National's
representative at the October 1973 meeting, made the following comment
about the proposed loan in a memorandum to the file:
Our loan would be to the Dial Investment Company, Inc., which as of
September 30, 1972, shows a net worth of $47,800. The strength to (sic) this
loan is in the guaranties of the two owners of Dial Investment Company, Inc.,
Donald Day and Ewel Karnes, Jr., who show respective net worths of
$3,077,600. and $4,042,400. Both of these gentlemen's net worth lies mainly in
their real estate equities. As partners (50-50 basis), they own approximately
800 apartments and 125 townhouses in Omaha, Bellevue and Grand Island,
Nebraska, area. All of these units are of high quality and consistently maintain
occupancy levels of nearly 100%. Through Dial Realty, Inc., Dial Construction
Company and Dial Investment Company, Inc., Don Day and Ewel Karnes have
built and developed over 2300 apartment units, several office buildings and
several shopping centers. In addition, they have put together three previous
planned developments similar to our proposal and all have been extremely
successful.
We will receive an assignment of all leases and rentals relating to the subject
property. The release schedule on specific areas and lots has been established
by F.M.C.C. and is based on 95% Of an appraised land value of $2,539,000.
We anticipate that the loan will never exceed $800,000. outstanding because of
the release structure. Heitman Mortgage Company will administer this loan for
us. (Emphasis added)

Although both Karnes and Day signed the promissory note, they signed only on
behalf of Dial Investment, Inc

Although the Klinker debt totalled $226,000, the building loan agreement
authorized the Bank to reserve.$390,000. The margin apparently was to cover

interest that would accumulate on the debt

5

The operative language of the policy read:

SUBJECT TO THE EXCLUSIONS FROM COVERAGE, THE
EXCEPTIONS CONTAINED IN SCHEDULE B AND THE PROVISIONS
OF THE CONDITIONS AND STIPULATIONS HEREOF, FIDELITY
NATIONAL TITLE INSURANCE COMPANY, a Nebraska corporation,
herein called the Company, insures as of Date of Policy shown in Schedule A,
against loss or damage, not exceeding the amount of insurance stated in
Schedule A, and costs, attorneys' fees and expenses which the Company may
become obligated to pay hereunder, sustained or incurred by the insured by
reason of:

Title to the estate or interest described in Schedule A being vested otherwise

than as stated therein;

Any defect in or lien or encumbrance on such title;

The priority of any lien or encumbrance over the lien of the insured mortgage.
(Emphasis added)

Our jurisdiction in this case is based on diversity of citizenship. Accordingly,

we must apply the appropriate state substantive law, in this case Nebraska's.
Hanna v. Plumer, 380 U.S. 460, 85 S.Ct. 1136, 14 L.Ed.2d 8 (1965); Erie R.R.
Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938)

Clearly First National did not "create" the prior encumbrances, although it may
have "suffered," "agreed to," or "assumed" them